Heterogeneous transmission mechanism: monetary policy and financial fragility in the eurozone[Which financial frictions? Parsing the evidence from the financial crisis of 2007-9]

The eurozone economic activity and banking sector have shown substantial fragility over the last years with remarkable country heterogeneity. Using detailed data on lending conditions and standards, we analyse – along several key dimensions of heterogeneity – how financial fragility has affected the transmission mechanism of the single eurozone monetary policy. The analysis shows that the monetary transmission mechanism is time-varying and influenced by the financial fragility of the sovereigns, banks, firms and households. The impact of monetary policy on aggregate output is stronger during the financial crisis, especially in countries facing increased sovereign financial distress. This amplification mechanism, moreover, operates through the credit channel, both the bank lending and the non-financial borrower balance-sheet channels. Our results suggest that the bank-lending channel has been to a large extent neutralized by the ECB non-standard monetary policy interventions, but the policy framework until the end of 2011 was insufficient to overcome credit availability problems stemming from deteriorated firm net worth and risk conditions, especially for small firms in countries under stress.— Matteo Ciccarelli, Angela Maddaloni and José-Luis Peydró